Workshop 18
(The Macroeconomic Environment)
Balance of Payments and Exchange Rates
1.
The following are the various elements of the UK balance of payments account:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
(l)
(m)
(n)
Imports of goods ()
Exports of goods (+)
Imports of services ()
Exports of services (+)
Other income and current outflows ()
Other income and current inflows (+)
Transfers of capital from the UK (–)
Transfers of capital to the UK (+)
Direct and portfolio UK investment overseas ()
Direct and portfolio investment in UK (+)
Other (mainly short-term) financial outflows ()
Other (mainly short-term) financial inflows (+)
Adding to reserves ()
Drawing on reserves (+)
Into which of the above categories would you put the following?
(i)
Blu-ray players imported from Japan. .................................................................................
(ii)
Insurance cover purchased at Lloyds in London by overseas residents. ..............................
(iii)
UK gives aid to finance capital project in a developing country .........................................
(iv)
Japanese car company purchases factory in UK. .................................................................
(v)
UK residents taking holidays in Florida. .............................................................................
(vi)
Interest earned by UK residents on assets abroad. ...............................................................
(vii)
Running down the stock of foreign exchange in the Bank of England ...............................
(viii)
New deposits made in banks in the UK by overseas residents. ...........................................
(ix)
Scotch whisky sold in France ..............................................................................................
(x)
UK insurance company sets up branch in Canada. ..............................................................
2.
The following shows how the UK’s balance of payments account is set out.
CREDITS
DEBITS
(1) Exports of goods
(2) Imports of goods
1 – 2 = Balance on trade in goods
(3) Exports of services
(4) Imports of services
3 – 4 = Balance on trade in services
(1 – 2) + (3 – 4) = Balance on trade in goods and services
(5) Incomes and current transfers from abroad
(6) Incomes and current transfers going abroad
5 – 6 = Other income flows
(1 – 2) + (3 – 4) + (5 – 6) = Current account balance
(7) Transfers of capital to UK from abroad
(8) Transfers of capital abroad from UK
7 – 8 Capital account balance
(9) Net investment in the UK from abroad
(10) UK net investment abroad
(11) Short-term financial inflows to UK
(12) Short-term financial outflows from UK
either (13) Drawing on reserves
or (14) Adding to reserves
(9 – 10) + (11 – 12) + (either 13 or 14) = Financial account balance
Current account balance + Capital account balance + Financial account balance
= Overall balance of payments
Overall balance of payments plus net errors and omissions = 0
The following are the items in the UK’s 2000 balance of payments (£ billions)
Exports of services ............................................................................67.2
Exports of goods .............................................................................187.1
UK net investment abroad (direct and portfolio) ............................250.6
Reserves (adding to = –ve)................................................................–3.9
Short-term financial inflows to UK ................................................281.8
Short-term financial outflows from UK ..........................................270.9
Capital transfers to UK from abroad ...................................................2.8
Capital transfers abroad from the UK .................................................0.8
Net incomes and current transfers from/to abroad ........................... +1.7
Imports of goods .............................................................................215.9
Imports of services ............................................................................56.3
Net investment in the UK from abroad (direct and portfolio) ........260.8
Using the table above, work out the figures for the UK for the following:
(a) The balance on trade in goods and services .............................................................................
(b) The current account balance ....................................................................................................
(c) The capital account balance .....................................................................................................
(d) The financial account balance ..................................................................................................
(e) Net errors and omissions..........................................................................................................
Note: You might wish to compare the various elements of the balance of payments in 2000 with the
same ones in 2011, which are given in Table 27.1 on page 446 of the textbook.
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3.
The following diagram shows a demand curve and supply curve of sterling against the euro.
S
1.80
€/ £
1.70
1.60
1.50
1.40
D
1.30
Q of sterling
(a) Who is demanding sterling in the diagram and for what purpose?
.................................................................................................................................................
(b) Who is supplying sterling in the diagram and for what purpose?
.................................................................................................................................................
(c) Mark the equilibrium exchange rate.
(d) Now illustrate the effect of an increased demand for sterling and a decreased supply.
(e) Has the exchange rate appreciated or depreciated? ...................... Appreciated / Depreciated
4.
Assume that there is a free-floating exchange rate. Will the following cause the exchange rate to
appreciate or depreciate? In each case you should consider whether there is a shift in the demand
or supply curves of sterling (or both) and which way the curve(s) shift(s).
(a) Imports increase.
Demand curve shift left / right / no shift
Supply curve shift left / right / no shift
Exchange rate appreciates / depreciates
(b) UK interest rates rise relative to those abroad.
Demand curve shift left / right / no shift
Supply curve shift left / right / no shift
Exchange rate appreciates / depreciates
(c) The UK experiences a lower rate of inflation than other
countries (assuming no change in interest rates). Demand curve shift left / right / no shift
Supply curve shift left / right / no shift
Exchange rate appreciates / depreciates
(d) Speculators believe that the rate of exchange will fall.
Demand curve shift left / right / no shift
Supply curve shift left / right / no shift
Exchange rate appreciates / depreciates
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5.
Assume that the government wishes to pursue a deflationary policy.
(a) What will happen to the exchange rate if it uses deflationary monetary policy?
Appreciate / Depreciate
(b) What effect will this exchange rate movement have on aggregate demand?
Increase it / Decrease it
(c) What will happen to the exchange rate if it uses deflationary fiscal policy?
Appreciate / Depreciate
(d) What effect will this exchange rate movement have on aggregate demand?
Increase it / Decrease it
6.
The use of interest rates as the main instrument for stabilising the exchange rate can often lead to
conflicts with internal policy objectives. In which of the following cases is there a clear conflict
between internal and external policy objectives, if interest rate changes are the only policy
instrument available to the government or central bank for achieving both sets of objectives?
(a) The government (or central bank) wants to prevent an appreciation of the exchange rate and
to reduce demand-deficient unemployment.
Yes / No
(b) The government (or central bank) wants to help domestic exporters and to reduce the rate of
inflation.
Yes / No
(c) The government (or central bank) wants to reduce the price of imports and to curb the rate of
growth in the money supply.
Yes / No
(d) The government (or central bank) wants to prevent a depreciation of the exchange rate and to
stimulate investment.
Yes / No
(e) The government (or central bank) wants to halt a rise in the exchange rate and to reduce the
rate of growth of the money supply.
Yes / No
(f) The government (or central bank) wants to reverse a recent fall in the exchange rate and to
reduce its unpopularity with home owners.
Yes / No
7.
Which of the following are likely to contribute to the volatility of exchange rates between the
major currencies?
(a)
(b)
(c)
(d)
(e)
(f)
(g)
A growth in the size of short-term capital flows relative to current account flows.
Yes / No
The abolition of exchange controls.
Yes / No
A harmonisation of international macroeconomic policies.
Yes / No
The adoption of money supply targets by individual countries.
Yes / No
The adoption of exchange rate targets by individual countries.
Yes / No
The adoption of inflation targets by individual countries.
Yes / No
A growing belief that speculation against exchange rate movements is likely to be stabilising.
Yes / No
(h) A growing belief that speculation against exchange rate movements is likely to be
destabilising.
Yes / No
(i) A growing ease of international transfers of funds.
Yes / No
(j) Countries’ business cycles become more synchronised with each other.
Yes / No
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